No Deal, No Problem – A Trump-Xi G20 Meeting Is Already a Win

Illustration: Craig Stephens

Presidents Donald Trump and Xi Jinping have finally agreed to meet at the upcoming G20 Summit. The news was confirmed last Tuesday by the White House, not through a briefing, media gaggle or press release, but with a tweet from Trump that “extended” talks will happen at the end of the month when world leaders gather in Osaka, Japan.

For those hoping that a resolution to trade tensions is near at hand, however, it is best to lower expectations now.

Neither side is itching for a compromise that could be easily interpreted as weak or conciliatory. Quite the opposite. If there was a meter measuring market pain for both countries, it has not yet pinged high enough for either side to change its position. That is what it will take because the tariff feud has turned into a contest of wills over a much broader geopoliticalstruggle.

The full op-ed is on the SCMP website.

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China Share of U.S. Imports Decline as Mexico, India, and SE Asia Gain

This op-ed originally appeared in the SCMP, May 20, 2019

China’s position as top US trade partner and largest source of American imports may be over as other economies gain from Beijing’s tariff troubles. Mexico and countries across Southeast Asia have already seen their percentage of US imports rise as China’s declines. This change will only accelerate as the trade war continues, and as of now there’s little reason to think it won’t go on for an extended period.

If US President Donald Trump raises tariffs on all Chinese imports, as he’s threatened to do, bilateral trade may never be the same.Shifting trends are already showing up in the trade data. While China continues to be a top source of US imports, sales in the first quarter of 2019 have dropped 14 per cent to US$106 billion from US$123 billion during the same three-month period last year, according to US Census data.

This is despite the US dollar strengthening against the Chinese yuan, making Chinese imports even cheaper. Mexico, the No 2 source of US imports, had the largest quarterly gains. Over the past decade, Chinese manufacturers have also lost market share in four out of its seven top US sectors, including computers, apparel, toys and furniture. Mexico’s share of the lucrative US computer segment grew to 32 per cent in 2018, from only 21 per cent in 2010. The recently negotiated US-Mexico-Canada trade agreement gives Mexican firms an even stronger advantage after Trump raised tariffs on Chinese imports.

Countries throughout Southeast Asia have also increased their market share in other top China categories. Vietnam has tripled its sales of apparel and textiles (non-wool or cotton) to nearly US$7 billion from US$2.25 billion in 2010. Taiwan, the Philippines, Thailand and Vietnam are also gaining on Chinese firms’ sales of computer accessories.

Chinese firms still account for half of all US imports of computer accessories, but other competitors are picking up significant market share. Collectively Taiwan, the Philippines, Thailand, Vietnam, and Mexico captured 28 per cent of this US import sector, up from 15 per cent at the beginning of the decade. These increases occurred despite Trump abandoning the Trans-Pacific Partnership, an agreement meant to eliminate tariffs among participating countries, which would have accelerated imports from Vietnam even faster.

India, too, is uniquely positioned to reap the benefits of shifting supply chains and its growing domestic market. According to the International Monetary Fund, India is already the fastest-growing major economy in the world and is expected to hit nearly 8 per cent in 2024, up from 7.1 per cent in 2018.

Construction has begun on the city of Amaravati, the new capital of the state of Andhra Pradesh. Photo: AFP

Construction on the city of Amaravati, the new capital of Andhra Pradesh, India. Photo: AFP

Gems have dominated exports to the US, but several Indian states, including Andhra Pradesh, in southeast India, are now home to mobile phone manufacturing plants. India’s cellphone exports to the US remain extremely small at present, but increases in capacity, rising skill levels and comparably lower wage costs that supply the booming domestic market may support export-oriented growth in the future.

India’s infrastructure projects are also expanding, providing US companies facing difficulties in China with new opportunities. Several cities are being built from the ground up, including Amaravati, the recently established capital of Andhra Pradesh. These projects feature green architecture, smart city technology, alternative energy and large-scale construction of residential and commercial buildings.

The World Economic Forum estimates that the automotive and electronics industries in the state alone could present a US$5 billion opportunity.The capital is one of several new developments in the world’s second most populous country and is emblematic of India’s economic rise as China’s own infrastructure spending comes under pressure. That’s good news for US construction equipment makers that have been caught up in China’s latest US$60 billion of retaliatory tariffs.

Difficulties, of course, litter the road to India becoming a global economic powerhouse. Fractious domestic politics, something single-party China has largely avoided, hobbled India’s potential for decades. Ports, road, rail and power currently lag more developed economies in the region. And the Trump administration has targeted India’s excessive tariffs on many US goods, opening up a possible new front in what is becoming his global war on trade.

Support for economic reform is being fostered by the US business community in India. In marked contrast, the business community in China, a long-time buffer to Washington trade hawks, have begun to sour on Beijing’s promises of change.The American Chamber of Commerce in China noted in its 2019 report that for the first time US business sentiment has turned from “cautiously optimistic” to “cautiously pessimistic”. That’s a sea change from years of rosy-viewed survey results.

Even for China’s industries of the future, carving out a sustainable portion of US imports will be difficult

For years they avoided confrontation over policies favouring Chinese domestic companies and forced technology transfer. They accepted short-term losses with the hopes of even greater profits in the future, all while dissuading the US government from more forcefully confronting China. Some now privately support Trump’s efforts to forge a more level playing field, though opposition to tariffs as the tool remains.

Domestic changes to China’s economy also make reclaiming lost market share among US imports increasingly difficult. Central planners in Beijing readily accepted that higherdomestic wages would force low-end manufacturing out of the country. Those jobs left and won’t be returning, much as they did for Japan, South Korea and Taiwan, which no longer make the vast majority of plastic toys and clothing for export.

Employees work on the production line of clothes for export at a factory in Xiayi county in China’s central Henan province in August 2018. Photo: AFP

Employees work on the production line of clothes for export at a factory in Xiayi county in China’s central Henan province in August 2018. Photo: AFP

Even for China’s industries of the future, carving out a sustainable portion of US imports will be difficult. Distrust over expansive intellectual property theft will remain a concern over Chinese hi-tech products like networking equipment, artificial intelligence and biotechnology, the principal areas targeted for future growth.

What the tariff fight now represents is a fundamental shift in the trading relationship. China’s pain is a gain for other countries eager to fill the import gap. This shift may turn into a structural change that will be extremely difficult to reverse. As threats rise from both sides of the Pacific, it may already be too late.

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How the U.S. Still Loses with a China Trade Deal

This op-ed originally appeared in the SCMP as “What the US will lose in a trade agreement with China,” SCMP 4/10/19

As the US and China get closer to a possible trade deal, the World Trade Organisation is set to lose its principal role as an arbiter of disputes. That has significant consequences for global trade, and underlined the re-emergence of bilateral agreements that once hindered global trade and development for decades. 

Illustration: Craig Stephens via SCMP

It’s no surprise that US President Donald Trump’s go-it-alone strategy to upend the status quo runs straight through Geneva. As a presidential candidate, he ran on rebellion. Once in office, he wasted no time reversing US participation in a variety of multilateral agreements.

He withdrew from the Trans Pacific Partnership (TPP), which the US had taken a leadership role in negotiating, and offered nothing to replace it. He imposed tariffs on much of the industrialised world, including allies Japan and the European Union, rather than bringing these disputes to the WTO. He also refused to nominate judges to the vitally important WTO Appellate Body, which inhibits the organisation from adjudicating cases.

His base probably didn’t care about these intricacies of international trade. Their economic anxieties could be assuaged, at least temporarily, by blaming foreigners in faraway places for taking their jobs.

This vision of world trade, fought as a zero-sum competition, is both troubling and naive.

In ordinary times, a dispute over market access or unfair trading practices would work its way through the international legal system. As litigants know, this can be a lengthy process. Even if the claims against a country turn out to be true, the appeals process can drag on while companies remain disadvantaged. Eventual penalties or other remedies may never fully compensate them for losses while other barriers to trade crop up in the meantime.

Instead, Trump unilaterally raised tariffs until China was compelled to negotiate directly with the US. If talks succeed, they will have made much swifter progress than a WTO case. The agreement is even reported to have an enforcement mechanism, whereby China’s adherence to its commitments will be judged under threat of reimposing tariffs. This way, the US retains direct leverage whenever the administration believes there’s been a breach of the agreement.

This all sounds perfectly reasonable – leverage the massive size of the US economy with its main trading partners to secure the best possible deal, all within a relatively short time frame. The world, it turns out, isn’t so simplistic.

A major point of contention for US negotiators is the trade deficit with China. Their solution reportedly includes Chinese government purchases of more US goods, a decidedly non-free-market solution. This fix can be easily reversed by the Chinese government in the future or delayed for any number of reasons – the domestic market may not be able to absorb those purchases, US suppliers may not be able to keep up with the demand, there may disputes over the prices set and the market distorting effects of “forced” purchasing.

Beijing is also no stranger to restricting purchases of imports for political purposes. Norwegian salmon imports were effectively barred from China for several years because Beijing disagreed with the Nobel Peace Prize award for jailed political dissident Liu Xiaobo. Restrictions and other non-tariff barriers to trade were also imposed on the Philippines for its territorial claims in the South China Sea.

Whatever the Trump administration negotiates with China will not be a durable solution, but rather a short-term political fix aimed at shoring up votes for the 2020 presidential election. Joining with similarly aggrieved WTO members to confront China could have created stronger, more lasting institutional-level change.

The negative impacts of this unilateralism are already being felt both domestically and abroad. US companies are losing out to their Canadian and Australian competitors in the lucrative Japanese market after the US withdrew from the TPP. Other countries such as Italy are turning to China’s “Belt and Road Initiative” instead of more traditional development lending institutions like the World Bank, with its extensive oversight mechanisms. That puts further strain on the legitimacy of the international system.

And that’s the point of Trump administration policies that promote a world where economic might makes right.

A fundamental principle of creating global rules of the road since 1947 was to make trade a win-win endeavour. Countries grew together as the overall size of their economies increased, in part due to the benefits of exports, which created new jobs. A rise in imports also increased competition and brought down prices. The current US administration downplays all of these advantages and instead focuses on the negatives of trade, purveying often false and misleading anecdotes of the damage open economies have on US workers.

Without doubt, China has been gaming the system for decades, alternately declaring itself a developing country that needs protection and a global economic powerhouse that deserves the respect of the world. It can’t be both. Entrance into the WTO gave China privileges as well as responsibilities.

As long as China’s market continued to grow, many advanced economies chose to ignore the heavily-tilted playing field. Only now when growth is slowing, the political environment is hardening and the government is actively supporting domestic companies, have the US, Europe and others decided to take action.

Trump’s tariffs have certainly been effective at getting China to the table. They have also been the wrong tool for the right problem. In the end, they will lead to short-term, ill-conceived solutions for temporary gains. Other countries will have to resort to similar bilateral negotiations as the WTO becomes weaker. That’s a terrible precedent to set. The world’s problems are becoming increasingly complex, requiring more cooperation, not less.

If this trend isn’t reversed and soon, there may be far more at stake than just the sale of soybeans and steel. US businesses, workers and consumers will have to live with the consequences long after Trump leaves the White House.


“Brand America” Falls Out of Favor With Foreign Investment

Trump understands that brand matters, and the latest version of brand America is failing badly. At this year’s World Economic Forum in Davos, business executives expressed not only concern, but outright dismay, over the investment climate in the U.S. And they aren’t just sitting on their capital waiting for better days.

Investors are voting with their money and heading for other countries. The statistics for Foreign Direct Investment in the U.S. (FDIUS) show a troubling trend. In the second quarter of last year FDI turned negative, a reversal of fortune not seen in years. That followed a drop of 41% year-on-year to $277 Billon in 2017, after peaking at nearly $472 billion 2016, according to U.S. government data.

Cyclical Decline in Foreign Direct Investment to the U.S.

Companies including Tesla, Unilever, and Foxconn are looking elsewhere to invest due in part to the uncertainty around the U.S.-China trade war. Imports and exports have been hit along with supply chain disruptions. While the upcoming trade talks in Washington were bathed in a positive light from governments on both sides of the Pacific, the outcome has been thrown into serious doubt after the Department of Justice announced criminal charges against Huawei and its CFO Meng Wanzhou. 

She is currently detained in Canada on an extradition request that is now sure to move forward. Trump has said he may intervene in her case if it serves the trade talks and U.S. national security. What he can actually do, politically or legally, remains unclear.

Trump Has Few Options
on Huawei Sanctions Trouble


The souring on brand America isn’t just about China trade disruptions. Trump’s immigration policies, his tacit acceptance of jingoistic and racist dog whistling by his most ardent supporters, and the perception that the U.S. is retreating from global affairs is turning away international students that might otherwise invest in a coveted U.S. education.

Enrollment in undergraduate programs dropped for the second year in a row with a 6.6% fall for 2017-2018. That’s putting new strains on colleges and universities that have grown accustomed to full-tuition paying foreign students.

The longer term cost to the U.S. will show up in worker shortages, primarily in science, technology, engineering, and math disciplines. These professions are already woefully short on trained graduates and unfilled jobs create a drag on economic growth.

While the administration touted $1.5 trillion dollars in corporate tax reductions that began in 2018, a survey by the National Association of Business Economics shows that companies are not in fact spending more. Trickle-down economics didn’t work under Reagan and it certainly isn’t working now even with a new, slick cover promising to make America great again.

A brand is only as good as what it delivers and so far Trump’s promises made continue to be promises broken. The U.S. accumulated a lot of good will over the decades. That hard-earned reputation is now at risk of being destroyed in only a few years.


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Conflicting Signals: USTR Ups Pressure on China and Treasury Talks Lifting Tariffs

Messaging is everything in international diplomacy, especially around high-level negotiations. After the latest round of U.S.-China trade talks in Beijing, all signs pointed to a successful outcome. An extra day was added beyond the planned two days of talks. Vice Premier Liu He made a short appearance at the lower-lower-level gathering of deputies. The U.S. Deputy Agriculture Secretary had glowing words after the meeting (though curiously no one from USTR spoke during the coveted press briefing.) Trump even tweeted shortly afterwards that the talks had gone very well.

And then the messaging changed, at least from USTR. 

Lighthizer said last week, according to Sen. Grassley who had met with him Friday, that he hadn’t seen the structural changes he was looking for from China. That’s a major sticking point for the White House and something Trump has repeatedly said must be addressed to avoid raising tariffs from 10% to 25% on Chinese goods.

It is an odd complaint since China would likely only agree to the far more difficult issues face-to-face at Cabinet-level negotiations with either USTR Lighthizer or President Trump. The Beijing meeting was a the Deputy level, a.k.a. not the decision makers.

Lighthizer also announced that if talks don’t work out, U.S. companies could apply for exclusions to the 25% tariffs on $200 billion of imports from China that are set to take affect in March.

That’s a weak nod to the U.S. business community who were directly affected by the 10% tariffs and are likely lobbying hard for a resolution to the trade impasse. The promise of exclusions provide cold comfort since the aim of the next round of tariffs is to put even more pressure on China. Any exclusions would weaken that influence. Approvals would likely be slow-rolled by the administration. 

USTR now appears to be trying to get out in front and push their hardline agenda ahead of the Jan. 30-31 talks. Sen. Grassley commented in a briefing to the press that since China’s economy is ailing there’s a chance to get more progress on these harder issues, which include IP protection, forced tech transfer, and stealing trade secrets.

These issues aren’t going away. The Department of Justice is now looking into whether Huawei stole robotic technology from T-Mobile.

To further complicate the administration’s signaling, Treasury Secretary Mnuchin has been discussing lifting tariffs as an incentive for China to make an equally bold move, though it’s unclear what that could be considering the depth of structural changes needed to satisfy U.S. concerns.

Since China isn’t going to agree to the U.S. list of over one hundred issues raised, and Trump isn’t going to accept some token purchases of U.S. goods and nothing else, some kind of compromise is necessary. What Grassley and other White House hardliners may not fully accept is that Trump’s approval ratings are plummeting, major U.S. companies are feeling the effects of the tariffs, and Trump himself may be itching for a settlement.

Compromise isn’t really in Trump’s winner-take-all approach and his impulsiveness can lead to unexpected outcomes (e.g. the Wall shutdown). The U.S. and China have been locked in a mutually reinforcing death spiral of tariff-raising for the past year and time is on no one’s side here.

USTR should certainly push for everything they can get. If cooler heads prevail, some sort of short-term relief with continued tariffs on some Chinese goods, and a plan to tackle the harder issues over time is the most likely outcome.

Both sides might not get exactly what they what, but it’s certainly better than the global economic carnage of a prolonged trade war and Trump really looks like he could use a win right now.


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Deal or No Deal in U.S.-China Trade Talks

U.S. negotiators are heading back after an extended trade negotiation with their Chinese counterparts in Beijing. While there’s been no formal agreement yet, both sides are expected to make public announcements on Thursday. If talks had gone badly something would have come out in the official Chinese state-run press by now, so all signs point to some kind of deal. Will it, however solve any of the more difficult challenges in the relationship?

Trump wants to see markets rebound. Chasing the sugar high of a stock jump is hardly a trade policy, and a terrible negotiating position. This essentially gave China added negotiating leverage knowing he is eager to settle. That doesn’t bode well for any substantial movement on the most difficult issues facing U.S. exporters — forced tech transfer, non-tariff barriers, and intellectual property theft. That was the whole reason Trump launched his ill-thought out trade war in the first place by ratcheting up tariffs on Chinese goods.

If there’s no movement on those hard issues, what was the point? China announced they’re going to be buying U.S. soybeans again, but China was already buying U.S. soybeans before Trump’s tariffs. That’s not a concession. 

China also announced that U.S. rice would be allowed into their market. While this is new, market access isn’t likely to dent the trade deficit as U.S. rice prices are significantly higher than other suppliers to China, most notable from Southeast Asia.

Other Chinese government moves included reduction in auto-tariffs, already offered to the rest of the world. While some legal reforms have been mentioned, enhancing IPR protection for example, changes in law are often not fully implemented. Given the inherently political nature of China’s judicial system, companies have little recourse.

These “structural” reforms tend to be the most difficult, often edging too close to issues that party hardliners in Beijing hold dear (e.g. favorable government and financial support to state-owned enterprises.) They’ll most likely kick the can down the road like they have for years and wait out what’s left of the Trump presidency.

That’s the crux of these negotiations. Are Chinese officials convinced that Trump will hold his line or will he cave to his own domestic economic pressures? It’s looking like Trump’s eagerness for a win will trump his own hardliners who are pushing for China to fundamentally change the way they do business. While that’s a laudable goal, they’ve used the wrong tool for this kind of heavy lifting.

Adding to the uncertainty, no senior-level negotiator was present for the talks. This was more of a working level negotiation and all of the familiar figures in Washington need to give their input including U.S. Trade Representative Lighthizer, Treasury Sec. Mnuchin, and Advisers Navarro and Kudlow. Interestingly it was mainly the Agriculture Deputy Secretary who spoke to the press, not the USTR Deputy Secretary, who ostensibly led the negotiations.

So what did Trump get out of all this turmoil? Hard to say until tomorrow, and there’s still three weeks to the March deadline, but there will be plenty of spin about the great, great, concessions that no U.S. president has ever gotten from China before. 

Expect an announcement highlighting all the U.S. goods China is going buy as a result. For comparison, from Jan. to Oct. 2018 China bought $102.5 billion in U.S. goods. Over the same period in 2017 the number was $104.5 billion (U.S. Census data for 2018 is currently available through Oct.) If the structural issues aren’t resolved, don’t expect too much difference in overall U.S. exports, especially as China’s economy slows down.

Markets react quickly to news, and then adjust to facts. Trump might still get his temporary stock bump, but a sugar high never lasts. China is playing the long game and a fickle market movement is about as small a win as it gets. 


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U.S.-China Trade Deal Already in Doubt

 

Trump Chaos Rattles China Trade Negotiations Before They Even Begin

Just days after President Trump claimed success in trade disputes with China, disagreement over the details have emerged. That rings with a familiar tune.

The Trump-Kim Summit this past June in Singapore raised similar doubts about what, if anything, was actually accomplished. It turns out that even with a loosely worded document we now know that nothing was formalized after that highly touted success.

While North Korea continues to develop missiles and possibly more nuclear weapons, Trump complains he hasn’t been offered the Nobel Peace Prize for his efforts. 

The Saturday Trump-Xi dinner in Buenos Aires didn’t even offer anything in writing and journalists were left guessing why applause erupted from behind closed doors as the dinner ended. There was no press conference or photo op to clear up the issue as Trump & Co. headed for the airport.

After landing, Trump claimed Chinese auto tariffs were being lifted. The White House has now walked that back. Trump claimed China would spend over $1 trillion on U.S. goods. His economic advisor Larry Kudlow said that was more aspirational than specific and would be determined by private entities and economic conditions. Trump said if China doesn’t make bold moves in ninety days, he’s Mr. Tariff, and then suggested the timeline might be extended.

No one knows what success looks like three months from now, and that’s a serious problem.

Now China has expressed its discontent with the White House version of winning it all. Yet again, Trump excels at undiplomatic posturing while others are left to clean up his mess.

The pattern here is clear. Trump’s erratic words cannot be trusted, only managed, even by those closest to him. It’s another episode of “Promises Made, Promises Broken.”

U.S. markets didn’t like that kind of uncertainty, and along with other negative financial news on Tuesday, they shed over 3% in one of the worst days in their history. 

Making matters worse, US Trade Representative Lighthizer replaced Treasury Secretary Mnuchin as lead negotiator. Lighthizer is a known China hawk, and while having someone strong-willed and skeptical at the table is an advantage, if the lead isn’t considered to be negotiating in good faith that will not end well for bilateral relations or the international trading system.

The biggest risk at the end of February will be China claiming they did everything they said they would do and the U.S. saying whatever they did wasn’t enough.

Chinese state media has already started making the list and announced increased punishments for firms found guilty of IP theft, but will they be implemented?   

If Trump really wants to reduce the trade deficit, protect intellectual property, and remove investment barriers, he and his team are going to have to be far more disciplined than they have been to date, and that seems highly unlikely.

Playing loose and fast with the facts, tweeting exaggerated wins, and painting Chinese negotiators into a corner will not make this relationship work. Both sides have to be able win.

 

G20 – What to Watch

 

 

11/30/18 – Updates on potential Trump-Putin meeting below.

The city center is bulking up on barricades and armed officers as world leaders being arriving for this year’s G20 meeting. Some 22,000 security personnel are being enlisted to keep the peace as anti-globalization and leftist political protests are expected, though they’ll be confined to a largely emptied part of town. The Argentine economy is under significant stress with 45% inflation and the peso more than doubling over the last two years against the dollar. Major parts of downtown will be completely closed, including cafes and shops. 

Saudi Arabia’s Crown Prince Mohammed Bin-Salman arrived on Wednesday and French President Macron is on the ground today. Trump is expected Friday along with several hundred press in tow. How many are fake news, but real people, will likely be tweeted ad nauseam starting late Saturday as Trump winds up his 48 hour stint in Argentina. 

Here are a few of the potentially most controversial issues to come out of the annual gathering.

 

Will there be a joint statement? 

After the debacle at APEC where the U.S. and China were at loggerheads over the final text and in an unusually thuggish move, the Chinese delegation stormed the offices of the Papua New Guinea Prime Minister’s office demanding changes. In the end there was no agreement over language for a final statement, the first time since APEC’s founding in 2003. 

For context, those final statements are mostly aspirational with very watered down, benign language that all participating countries can sign off on. They aren’t even legally binding. Early drafts are usually negotiated well in advance.

Will the same happen at the G20 with an even more complex set of issues in play including climate change (which Trump doesn’t believe is a scientific fact), migration (U.S. troops still on the border with Mexico), economic growth, health, sustainable development, the international financial architecture, and a host of other issues in addition to an “Action Plan.”

For comparison here’s a link to last year’s statement. 2017 G20 Leader’s Declaration 

 

Lots of Deals, or Not

Part and parcel of G20 gatherings are major business deal announcements and project financing, aka deliverables. Most, if not all of these, have either been in the works for months or already started, but it makes the event look like a venue where things get done. China is funding Argentina’s fourth nuclear power plant and if the proliferation of China’s ICBC bank branches across the capital are any indication, financial ties are strengthening even during Argentina’s economic downturn (Citibank sold its retail operations to Santander in 2016 further shrinking U.S bank presence in the country.)

Teatro Colón (Colón Theatre) in Buenos Aires
Site of cultural event for Leader’s Summit

What, if anything, will the U.S. be announcing in terms of large deals in Latin America? The re-negotiated NAFTA with Mexico and Canada is already old news as is Argentina’s new beef exports to the U.S. China’s financing largesse is likely to overshadow any announcements by Trump unless the numbers are “bigly” and “yuge.” There are no signs of that happening.

Trump-Xi Statement

Rumor has it Trump and Xi are meeting for dinner on Saturday night, with the venue and menu yet to be reported. The outcome of that feast may well determine the near-term future of global trading relations, major stock market movements, and a wave of punditry over the temperature of a new Cold War. Trump’s economic adviser, Larry Kudlow, tried to strike a positive tone this week suggesting a deal could be made over the tit-for-tat tariffs that have roiled markets, while hedging with a statement that China needs to offer more. Trump, with his illimitable bravado, threatened even more tariffs.

Meanwhile China’s President Xi continues to travel the world (most recently Spain) and continues to tout support for free markets and the allure of China’s growing market. So far there’s been no mention of structural reform and there likely won’t be. State-owned enterprises are a fixture of China’s Communist Party rule despite its turn towards capitalism, and no threat from the U.S is going to change that. 

 

Trump-Putin Meeting

Update 11/30/18 12:54 – Russia says a meeting with Trump is still on as with other leaders. WH says nothing has changed. They may be splitting hairs on what “meeting” means. Technically a “pull aside” is not an “official” meeting since it doesn’t involve a formal sit down with advisors, etc. and can take place for a very short time. A pull aside also doesn’t carry the same gravitas as a formal meeting, but leaders still talk to each other, and usually without press or even a briefing afterwards.

Update 11/29/18 11:45 – Trump tweets cancellation of his G20 meeting with Putin citing Russia’s continued seizure of Ukrainian ships and crew. That leaves door open if they’re released in the next two days, but suspicions swirl that this has to do with more Cohen revelations of pursuing a Moscow deal during the campaign.

Official White House Cancellation of Putin Meeting Announced via Tweet

As of 11/29 the meeting has been cancelled via Trump’s tweet and then on 11/30 Russia says they will still meet. Who knows what “meet” means anymore.

No matter how this pans out, the on-again, off-again announcements make the U.S. look weak and confused. If Trump does end up meeting Putin, even in an “unofficial” pull-aside, he appears to be dancing to Russia’s balalaika (stringed Russian musical instrument.) There will be no time for an in depth discussion of Iran, missile treaties, Ukraine, North Korea, Syria, or a handful of other pressing issues. 

It’s amateur hour in Buenos Aires for the U.S. delegation, in part or by design thanks to Trump’s inability to stay on point and engage with the international community in any strategic way. Have no doubt though that WH Comms will spin this as a series of successful events during an intense two days of high stakes diplomacy.  

. . . It will certainly be a whirlwind few days of summitry, though don’t expect any mountain peaks to be topped with major announcements. 

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What the China Stock Market Crash Really Tells Us (and What It Doesn’t)

Monday morning headlines were more sobering than a double shot of espresso, adding anxiety to an already tumultuous few weeks in China. The Shanghai index dropped 8.5%, in one day, again. This after a see-saw struggle to regain momentum with similar drops from mid-June’s dizzying peak of over 5,000.

The consequences of such a serious correction, with a Monday close at 3209.91, are neither dire nor surprising and the ensuing panic will likely bring out a host of incorrect linkages.

Here are three misconceptions of what the crash seems to mean, but doesn’t.

1. The China market crash will destroy the U.S. economy

U.S. exports to China totaled a mere 7% of total U.S. exports year to date. Canada and Mexico represent a combined 34%.

Exports in general make up an extremely small percentage of the U.S. $18 trillion economy (about 8%) and exports to China represent an even smaller amount.

Over two-thirds of all U.S. economic activity is driven by consumers. The biggest impact on that activity is whether people feel they have more money to spend today than yesterday, not on whether day traders in Pudong are pulling their money out of Sinopec shares.

2. Shanghai and Shenzhen stock markets represent the broader Chinese economy  

Usually a broad-based stock market sell-off represents a belief that the underlying economy isn’t going to do as well going forward as it has in the past. That’s the rational explanation assuming near perfect knowledge of economic conditions. Even the U.S. market doesn’t work that efficiently (there are sell-offs even without new negative economic information.)

In China, knowledge of the broader economic slowdown has been around for a while. If the markets were rational they should have been dropping when the government announced lower growth targets back in March. They should have dropped as alternate economic measures hinted that the official 7% growth rate might not be reached.

Instead they continued to climb based primarily on two non-economic beliefs. The self-fulfilling prophecy that the market could only go up and that the Chinese government would prop up any market weakness. Win-win.

Since domestic savers have very limited choices of where to put their money, once the real estate two-step dance was over (buy one to live-in, buy one to hold) the stock market became the only game in town attracting a flood of capital. That rush caused prices to rise which attracted even more investment, much of it borrowed on margin. Thus the illusion of a perpetually rising market.

The Shanghai composite has now dropped below the magical 3,500 level where many believed the Chinese government would step in with massive buying to push prices back up. The illusion of invincibility appears to be faltering. Meanwhile online sales in the real economy continue to expand.

In this market there is no irrational exuberance with Chinese characteristics, just irrational exuberance as rationality returns to the market.

3. The China sell-off is similar to previous Asian financial crises   

In 1997 the Thai Baht came under heavy pressure resulting in large scale contagion throughout the region. A heavily reliance on trade with a market-determined exchange rates drove this spread. China has neither.

China’s yuan, despite recent changes, remains a managed currency. The government still decides on its opening daily price. That means speculators cannot significantly alter its value beyond a government imposed trading band of +/- 2 percent per day.

China’s economy is also far less reliant on trade than in the past as government investment in infrastructure as well as real estate development have become main drivers of growth. Of those industries dependent on trade China’s recent devaluation made Chinese exports cheaper (a dollar or euro buys more today than in the recent past).

What does the recent sell-off really tell us?

The Chinese government is going to have an increasingly difficult time trying to stop the carnage. Despite conventional wisdom, it does not have unlimited power. By even trying to manage the sell-off, policymakers have placed themselves in an extremely difficult situation.

If they can’t right the market as people expect the government looks weak. If they impose even more draconian rules to stop sellers from liquidating they may kill interest in the market as a whole. Lose-lose.

Apple’s Tim Cook, for one is not that concerned about purchasing habits in China. Let’s hope that the nascent middle class has more cash stashed at home that they’re willing to spend than most people think.

Meanwhile the China market crash has caused a flash sale on a host of solid U.S. equities.

China Devaluation Latest Sign of Market Weakness

The People’s Bank of China (PBOC) devalued the renminbi yesterday in the latest sign that market forces continue to weaken in the world’s second largest economy.

Exports have fallen. Growth is likely far slower than the official 7% rate. Electricity usage is down. Steel production has declined. Infrastructure investment yields less impact. Even demographics highlight a shrinking workforce (enter the robots). And then there’s the stock market, largely divorced from the underlying economy and gyrating like hips at a hula hoop competition.

Currency devaluation will do little to reverse these trends.

As a short term fix it may help exporters whose goods are now cheaper to buy abroad, slow capital flight (it costs more to convert renminbi into other currencies) and potentially attract more foreign investment into the country (a U.S. dollar today buys more renminbi than a dollar yesterday).

But the underlying economic uncertainty in China’s partial transition to domestic led growth will continue to weigh heavily on the minds of international investors and policymakers alike.

If China truly wants to make the renminbi a global reserve currency the PBOC will have to reverse itself and let the currency float freely like the yen, euro and pound. That requires giving up managing a trading band around a fixed daily rate. Economic conditions would have to improve significantly before moves in that direction resume (almost certainly a gradual step-by-step process).

None of this means a hard landing for China’s go-go economy, but resorting to a currency devaluation highlights the limited policy options left for a government navigating increasingly choppy waters.

Remaining moves (and ones largely ignored to date) include government heavily investing in a social safety net, improving health care coverage and promoting more affordable housing. That will allow households to free up some of their savings to spend and spur new business creation.

Until this happens expect more partial solutions and continued volatility.